Picking up Property With Renting in Mind

Rental Properties Can be Very Profitable

The Johnson's new summer home offered solitude along with the cool nights of the Blue Ridge Mountains. The perfect escape from Florida's hot, humid summers.
When a consulting job led them to Denmark for six months, the Johnson family decided to rent out their little bit of heaven. Having leased their beach-front condominium for several years, they felt comfortable when approached by a local real-estate agent.

"We were promised handsome rents if we would be willing to rent short term," says Mr. Johnson. "By renting the house for holiday weekends and one-week stays we could earn all of our monthly expenses in just one week."

For casual landlords trying to cover the expenses of a second home, renting may seem like a good idea. A May report by the National Association of Realtors indicated a record 377,000 second homes were bought by Americans in 1999, up more than 9 percent from the previous report, in 1997. About half were for at least part-time rental, says an NAR spokesman.

Tenants can be trouble

But the cost of renting out such a home may be too great in terms of physical damage and emotional wear and tear.

Unless they employ caretakers, rental-property owners who live any distance from their holdings can have a hard time learning about such problems as water damage, break-ins, or fallen limbs.

They can also have trouble policing short-term tenants.

Returning from abroad, the Johnsons heard neighbors recount stories of strange chanting coming from their house on several weekends. They found their dream house in shambles. The wood floors were gouged, the furniture moved all over the house. Candles placed in the open beams had dripped down the paneled walls.

"Because these were short-term rentals, there was no pre-screening of tenants, no leases or security deposits. The real-estate agent set up the rentals and collected the rent, but was not responsible for damage done by these short-term renters," says Mr. Johnson.

Rethinking the rental strategy

Still, this experience did not deter the Johnson family from investing in rental properties. It did, however, lead them to take a different tack.

When their accountant recommended real estate as a way to diversify their investment portfolio, they went shopping for small rentals. After looking at several properties, they settled on a modest duplex and fourplex to get them started.

During the first half of the past century, before the Internet and Silicon Valley, real estate created more millionaires than any other industry. In some business analysts' eyes, the risk associated with rental property remains less than that of sailing the uncharted waters of electronic commerce. And it has the capacity to recover from slumps. Consider Donald Trump.

For those looking to establish future income - especially to those ready to put in some "sweat equity" - income property is becoming more popular. If you are handy, buying "fixer uppers" can be a way to build your fortune with rental houses.

Rick Slater of Melbourne, Fla., has purchased run-down houses for rental properties and for "flipping." That is, fixing up the properties and selling them.

Buy and Sell

"Buy, fix it up, and sell it quickly," says Mr. Sater. "The best time to make money on a property is when you buy it. Find a good real-estate agent who can find you the best deals. And then that Realtor can help you sell the property."

Look to banks for distressed properties.

Slater also suggests banks and savings and loans are a good source of fixer uppers. "Many foreclosed properties are distressed and the banks just want to dump them. Look at what comparable properties are selling for in the neighborhood. You have to buy considerably below those prices if you are going to make money on the resale."

As with any investment, you must get a fair return on your investment. The more money you borrow, the greater your return on investment must be in order to repay the loan.

When banks look at loans for investment properties, hey look to the ability of the property to repay the loan. They look at the cash flow and net income the property will produce.

Cash flow is the amount of money the property will generate. Net income is the amount of money left after all expenses are paid. Expenses include repairs and maintenance of the property, legal fees, accounting fees, taxes, insurance, and management.

The bank will want to see net income equal to about 120 percent of the monthly mortgage payment.

If the property is already rented, they will look at the actual rents. If not, they will look to the appraiser to indicate market rents. Appraisers evaluate income property by comparing the rents at similar nearby properties.

These rents are adjusted for factors relating to the size of the rental units, the overall condition, and convenience to transportation, schools, and shopping.

Being a landlord is not for everyone.

Beyond the rental income comes the problems associated with dealing with tenants and property maintenance.

"I held 10 or 11 of the properties I rehabbed for rentals," says Slater. "It got to be too stressful. I eventually sold all the properties."